New federal rules take aim at shady practices of debt-settlement companies

Michelle Singletary
Wednesday, September 29, 2010;
8:17 PM

Got debt?

Well, if you do, the federal government has made it more difficult for unscrupulous or sham debt-settlement companies to make false claims that much of your debt can be easily erased.

Debt-settlement or debt-relief services promise to renegotiate or in some way change what you owe to an unsecured creditor or debt collector.

As the economy tanked, many people fell behind on their consumer loans and as a result were drawn in desperation to firms that claimed they could, in some cases, cut debts in half. The promised assistance might have included finding ways to reduce a debt balance, an interest rate or penalty fees.

Law enforcement officials have increasingly been receiving complaints about companies that collected fees but did little, if anything, to settle people's debts. The Better Business Bureau said that since the recession started in late 2007, it has received thousands of consumer complaints from all 50 states about debt-settlement companies that have driven people deeper into the hole, in some cases causing them to be sued by creditors or even to have wages garnished.

To curb deceptive practices, as of Monday, new rules being implemented by the Federal Trade Commission require debt-relief companies to make specific disclosures to potential customers, such as how long it will take to get results, how much the service will cost and the potential negative consequences that could result from seeking debt relief. The firms are also prohibited from misrepresenting what they can do for debtors, in particular the percentage of debt that is typically erased. For example, in calculating how well a company has done for customers, a debt-relief service has to include those customers who dropped out or otherwise failed to complete the program.

The new rules amend the Telemarketing Sales Rule and specifically cover telemarketers of for-profit debt-relief services, including those offering credit counseling, debt settlement and debt negotiation services. Legitimate nonprofit organizations that help people renegotiate their debts aren't covered under the new rules. However, companies that falsely claim nonprofit status are subject to the FTC standards.

It's important to note that the rules cover telephone calls made to potential customers and calls made by debtors in response to advertisements and other solicitations, including people working on behalf of a debt-relief firm.

Another phase of the law will take effect next month, and it's significant. Beginning Oct. 27, it will be illegal for a debt-relief service to charge upfront fees. Companies that sell their services over the telephone won't be able to get paid until they successfully settle or reduce a customer's credit card or other unsecured debt.

The fees are often based on a percentage of the amount of debt that you want help with. Let's say you owe $20,000 on four credit cards. You might be charged a fee of 15 percent ($3,000) of the debt you want reduced. Here's the problem. You would pay the fee regardless of how many of the accounts, if any, are actually settled, according to the Consumer Federation of America.

There are also provisions on how money set aside for a settlement offer is to be handled. Customers are told to stop paying their bills and instead send money to the debt-settlement firm with the intention of offering creditors a lump-sum offer for less than what's owed. Under the new rules, a dedicated account has to be established at an insured financial institution, and the money belongs to the client, who can withdraw it anytime without penalty.

These new rules are a great first start, but Congress needs to close some loopholes. The rules don't limit the amount of fees companies can charge. There's just too much room to gouge people. Sen. Charles E. Schumer (D-N.Y.) has introduced legislation that would limit debt-settlement fees.

Further, the rules need to expand beyond debt-relief services offered by telephone. Providers who meet face to face with people before signing them up are exempt from most of the new provisions.

This effort should help stem the scams, but it won't stamp them out. There are just too many desperate debtors willing to believe anything if it means getting relief from their bills.

"It's significant that the FTC is cracking down on the offending debt-settlement companies, but real protection for consumers will mean enforcing the rules, and that'll be harder," said Chris Viale, chief executive of the nonprofit Cambridge Credit Counseling.

If you're in debt, learn about your new protections. Otherwise, you'll just make a bad situation worse. And don't believe in easy fixes. There aren't any.

Readers can write to Michelle Singletary at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071. Comments and questions are welcome, but because of the volume of mail, personal responses are not always possible. Please note that comments or questions might be used in a future column, with the writer's name, unless a specific request to do otherwise is indicated.